Utility Week

UTILITY WEEK | SEPTEMBER 2021 | 13 Policy & Regulation Analysis Macquarie bets on Southern It's been 18 months of disastrous headlines and regulatory fines for Southern Water, but that hasn't stopped Australian fund Macquarie coming forward with £1bn for a stake in the beleaguered company. I n February 2020, Southern Water stated its intention of "becoming brilliant at the basics". Eighteen months on, that ambi- tion has been severely tarnished and brings back memories of the Major government in the 1990s, which went "back to basics" with disastrous political consequences. In recent years, Southern has become the whipping boy of the water sector. But, for various reasons, it has just attracted a new investor, the well-known Australian fund Macquarie, which has promised over £1 bil- lion of new equity investment. With net debt now exceeding £5 billion, it is much-needed because Southern's invest- ment strategy and operational capabilities have attracted trenchant criticism. Recently, Southern was fined £90 million for dumping raw sewage at sea. Mr Justice Johnson concluded that "each of 51 offences seen in isolation shows a shocking and wholesale disregard for the environment". Neither was former Ofwat chief execu- tive Rachel Fletcher overly impressed when Southern was fined £126 million in 2019 for misreporting the performance of its waste- water treatment works. She stated: "What we found in this case is shocking." And The Pensions Regulator (TPR) was also on Southern's trail. TPR executive Nicola Parish concluded that "in our view, the pension scheme was not being treated fairly". Southern was required to contribute £50 million to make up the shortfall. These issues took place against the back- ground of a far tougher water sector periodic review, covering the April 2020 to March 2025 quinquennium. Unlike some water compa- nies, Southern did not appeal its final deter- mination to the Competition and Markets Authority (CMA). Given the latter's quixotic rulings regard- ing Ofwat's pivotal Wacc (weighted average cost of capital) assumptions, which would have incensed Ofwat's senior executives, Southern's board may rue this decision. Indeed, in accepting its final determina- tion, Southern highlighted Ofwat's punitive Outcome Delivery Incentive (ODI) regime. Macquarie will aim to turn round the Southern business; it can point to undoubted success as a global infrastructure player, earning good returns for its investors. How- ever, in the UK water sector, its reputation is more tainted, especially through its heavy – and controversial – investment in Thames Water, as a recent coruscating article in the Daily Telegraph highlighted. As a key investor for a decade in the con- sortium, Macquarie presided over a mas- sive increase in Thames' net debt – to over £10 billion – while dividends of over £1.5 bil- lion were paid: Corporation Tax payments were minimal. Importantly, Macquarie has access to funds that should now enable Southern's five-year investment programme to be delivered. In its PR19 final determination, Southern was allocated a wholesale totex figure of over £3.6 billion between 2020/21 and 2024/25: around 60 per cent of this figure was ear- marked for its sewerage operations. Seem- ingly, Southern needs to spend more than this figure. Having been privatised in 1989, it is not clear why, over 30 years later, it finds itself in such a mess. A¦er all, Severn Trent, for example, is thriving as a publicly quoted company, with a valuation of over £7 billion. Unlike Severn Trent, Southern is dispro- portionately dependent upon its sewerage business, partly for historical reasons since many water-only businesses (formerly statu- tory water companies) are based on its patch. Many of Southern's treatment works were built pre-war, whereas South West, another water company with many bathing beaches in its region, invested heavily in new sewer- age infrastructure from the mid-1990s. Southern's case was not helped by sev- eral items being disallowed by Ofwat during PR19. A proposal to invest £33.1 million to tackle excess leakage levels was struck out – rightly or wrongly – by Ofwat: Macquarie has now pledged extra expenditure to reduce leakage. For Southern's customers, Ofwat's PR19 prescribed real price cuts until 2025 – aver- age bills, prior to inflation, were due to fall from £420 in 2019/20 to just £343 by 2024/25. Macquarie, though, has simply promised to "ensure that average water and wastewa- ter customer bills, in aggregate, do not rise by more than inflation". In seeking to turn round Southern, Mac- quarie recognises that the process will take time. The one certainty is that Macquarie seems set to pursue a rather different path from that adopted during its period as a lead shareholder of Thames. Ofwat itself has emphasised the priority it accords to both operating and financial resilience – neither of which Southern has offered of late. More generally, the Southern saga – and its lengthy charge sheet – has been a lousy advert for the benefits of utility privatisation, as many other water company executives privately concede. And, in Southern's case, in its core activ- ity of running a regulated sewerage business – it has certainly not been "brilliant at the basics". Nigel Hawkins is a Utility Week correspondent and the utility analyst at Hardman and Co, a City-based investment research house. Southern will welcome the vote of confidence – and the cash

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